Investigating Mutual Fund Correlations
Tip It!This is just a quick note to point out a useful tool that I ran across while researching our ideal asset allocation. Simply head over to Adviser Online’s Fund Correlation Tool and you can easily determine the correlation between any pair of Vanguard mutual funds.
In case you’re not familiar with the concept of correlation, it’s simply a statistical measure of the degree to which two variables change in concert. A correlation of +1 refers to an increasing linear relationship, whereas a correlation of -1 refers to a decreasing linear relationship. A correlation of zero means that two variables move independently of one another.
While I’m grossly oversimplifying things here, a properly diversified portfolio contains a variety of different security classes with low or even negative correlations. Having this sort of investment mix helps to ensure that when some of your investments are suffering, others are thriving (or at least suffering less), thereby reducing your overall investment risk.
Note that the fund correlation tool reports the correlation coefficient in terms of percentages, so the data points can actually range from -100 to +100.
Some examples…
Large Cap Index vs. Small Cap Index: 89%
Total Stock Market Index vs. Total International Index: 74%
Total Stock Market Index vs. Total Bond Market Index: -17%
Even if you don’t have access to Vanguard funds, this is a great tool for getting a feel for how different asset classes perform relative to one another.
As you can see from above, domestic equities exhibit a relatively strong positive correlation with each other, even when comparing between large and small cap stocks. Likewise, domestic and international equities are reasonably well correlated, though less so than large vs. small cap stocks.
In contrast, stocks and bonds have a slight negative correlation, meaning that increasing in stock values are typically accompanied by decreases in bond prices, and vice versa.
Published on April 16th, 2008 - 9 Comments
Filed under: Online, Saving & Investing
About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!
Related articles...
» How Much International Exposure Should Your Portfolio Have?» Favorite Mutual Fund Company?
» Schwab Mutual Funds: Ideal for Investors With Limited Means?
» Mutual Fund Sales Loads: Just Say No
» Favorite Mutual Fund Companies: The Results
» Expense Ratios as Predictors of Mutual Fund Performance
» Making Your Initial Mutual Fund Investment
» Converting Mutual Funds Into Exchange Traded Funds (ETFs) Without Incurring Taxes
Was this article useful? Please sign up to receive our content via e-mail:
9 Responses to “Investigating Mutual Fund Correlations”
Leave a Reply
Top Cards by Category
Earn $200 Bonus Cash Back after you make $500 in purchases in your first 3 months. 5% Cash Back on up to $1,500 spent in bonus categories each quarter.
Receive 10,000 Membership Rewards bonus points when you spend $500 in your first three months of card membership. Redeem bonus points for gift cards valued at $100. This is a charge card with no pre-set spending limit.
Earn 3X points on airfare, 2X points on gas and groceries, and 1X points on everything else.
Enjoy a 0% introductory rate for 18 months on Balance Transfers and 6 months on Purchases. Earn up to 5% cash back in categories that change.
Enjoy no balance transfer fee for a limited time. 0% introductory rate on Balance Transfers and Purchases. Earn up to 5% Cashback Bonus in categories that change like gas, restaurants, department stores and more. Limitations apply*
Enjoy no balance transfer fee for a limited time. 0% introductory rate on Balance Transfers and Purchases. Earn up to 5% Cashback Bonus in categories that change like gas, restaurants, department stores and more. Limitations apply*
Enjoy amenities for you and your business, like: complimentary airport club access, including American Airlines Admirals Club(R) lounges.
5% Cashback Bonus in categories that change like gas, restaurants, department stores and more. Limitations apply*. Up to 1% unlimited Cashback Bonus on everything else. No annual fee
Earn 3X points on airfare, 2X points on gas and groceries, and 1X points on everything else.
Reports to 3 major credit bureaus monthly and acceptance at millions of locations worldwide, including website purchases and reservations.
- How to Become a Millionaire
- How to Get Out of Debt
- The Best Dollars I've Ever Spent
- How Our Estate Plan is Structured
- How We Paid Our Mortgage In Less than 10 Years
- Money Making Ideas
- How to Manage Your Asset Allocation with Multiple Accounts
- Consumption Smoothing - Save While the Saving's Good
- How to Save on Groceries
- How Much Life Insurance Do You Need?
- Eleven Great Books About Money
- Dave Ramsey is Bad at Math
- Dish Network Customer Service SUCKS
- $8,000 Homebuyer Tax Credit
- Pay Off Mortgage Early or Invest?
- How to Claim the First-Time Homebuyer Tax Credit
- Reduced Credit Limits? Share Your Experience
- $15,000 Homebuyer Tax Credit
- Ethanol Blended Gas = Lower Mileage?
- Termite Control: Sentricon vs. Termidor
- How Much Should You Pay a Babysitter?
- Federal Income Tax Rates Went Down but Your Federal Tax Withholding Increased. Here's Why...
- Would the "Fair Tax" Gut the Economy?
How to save money on insurance
- Double-Check Your Ally CDs
- Stocks are Not Bonds, CDs, or Savings Accounts
- The Best Values in Colleges - 2012 Edition
- Five Myths About Renter's Insurance
- Own Your Investments, Rent Your Fun
- Citibank to Issue Credit Cards in China
- Heartstrings and Pursestrings
- Saving Money at the Grocery Store: Store Brand Pricing on the Rise
- Missing Tax Paperwork?
- Is Your Investment Allocation Right?
April 16th, 2008 at 11:23 am
This is why a little exposure to bonds is always a good bet. I wouldn’t put a large percentage or my portfolio there but having a little balance doesn’t hurt.
April 16th, 2008 at 12:55 pm
Wow, I never thought concepts from my “Probabilistic Methods” class would ever be useful for me. Makes me wish I didn’t sell my textbook!
April 16th, 2008 at 1:22 pm
One thing I’ve been curious about in terms of “secure” portion of a portfolio is why the bonds are usually mentioned instead of CDs. Sure at some point in the 80s, bonds had higher yields, but recently, the yield on CDs is higher than yield-to-maturity on AAA bonds — just searched through AAA bonds on my brokerage account.
I am not talking about bond funds, since these don’t have maturity date and carry a whole lot more risk than individual AAA-rated bonds.
This is a question to those more knowledgeable than I am. A bunch of my CDs mature in May, and I\’ve been trying to find some good place for them which has to be in \”safe\” portion of my portfolio to maintain my desired allocation. I’ve already bought max allowed number of series I bonds for the year.
April 16th, 2008 at 1:32 pm
Thanks for linking to this tool, it’s a new one to me. I’m surprised to see large cap to small cap at just 89%. Of course, correlations change over time, so we need to keep checking back.
April 16th, 2008 at 1:56 pm
This is an useful tool. Does anybody know how far back they go in calculating these correlations? I’m guessing it’s 36 months since that’s what Vanguard reports on their website. It would be even more interesting if they had a way to compare 3 or 4 funds with each other in a portfolio and calculate the CAGR and Std Dev of the portfolio over the past 36 months or whatever time period they use.
April 17th, 2008 at 10:16 am
Not to get too geeky, but a correlation of -1 is also a perfect linear relationship, just as +1 is, albeit inverse. Just trying to clarify your “a correlation of -1 refers to a decreasing linear relationship” statement.
Nice tool though, very useful.
April 17th, 2008 at 10:45 am
Steve: I’m not sure exactly what you’re trying to correct. Linear = linear. Had I said “approximately linear” then you’d have a point, but when someone specifies a linear relationship, it’s typically in reference to a 1 to 1 (or 1 to -1) relationship (i.e., “perfectly” linear).
April 17th, 2008 at 1:18 pm
Correction withdrawn as it looks like Wiki has your terminology also. My thought was that your wording implied the linear relationship is decreasing (growing weaker) as it reached -1.
We must have different backgrounds, but correlations are always described as positive/negative linear or direct/inverse linear in my field to avoid this very confusion.
April 17th, 2008 at 1:25 pm
Gotcha… Yes, I can see how decreasing vs. negative could be confusing. I was thinking in terms of the slope of the relationship. Thanks for the clarification.